Walking Away from a Mortgage – Is It Ever Smart?

Is walking away from a mortgage ever a good move? I just had tea with a friend of mine, Sharon. She owes $100,000 more on her home than it’s worth. On top of that, she works for a company that is going through tough times, and she’s worried about getting fired and then having to find a new job. For a woman in her sixties, this isn’t a promising picture.

Sharon was convinced that she should walk away from her mortgage – not the home. She planned on staying in the home and not making payments. She was considering this move because she was angry.

Unfortunately Sharon bought at the peak of the market and locked in high interest rates (relative to today). She kept hearing about people who were able to get loan modifications and rate reductions. She contacted the bank to ask if she could refinance her mortgage. They refused to even return her calls. Like I said, Sharon was angry and wanted to “stick it to the man.”

Her husband, Bill, was of another mind. He didn’t want to ruin his credit and didn’t like the idea of becoming a renter. He worried about borrowing money in the future. How could they reconcile their different directions?

First we tried to separate out all the issues. Sharon had a right to be angry, but that wasn’t going to change the situation. If a good decision was to be made, clear-headed thinking had to prevail. But Sharon was right about a few other things. The house might indeed continue to decline in value. If that happens, they’ll continue throwing good money after bad – not a smart financial move.

But Bill also had some good points. He mentioned that nobody forced them to sign the loan documents or buy the home in the first place. They did so of their own free will. Also, since Sharon hadn’t lost her job yet, they weren’t forced to make any move at the present. He astutely pointed out that if and when Sharon lost her job, that might be the time to hard-ball with the bank.

Together we calculated that they’d save about $20,000 if they were able to stay in the home for a year without paying rent or the mortgage. After that, they’d be forced to rent and the rent would be about what they pay now in mortgage payments (after the tax benefits).

From a purely financial standpoint, it made no sense for Bill and Sharon to allow their home to be foreclosed on. In fact, by keeping current with the mortgage, they could still take advantage of any strengthening in the real estate market, should that occur.

Sharon would not be dissuaded. She was so angry at the banks, the situation and herself that she couldn’t see straight. She was determined to stop making payments on her home and to allow the bank to begin the lengthy process of foreclosure and eviction.

Again, the most this couple would gain by going this route would be $20,000 – and it would be much less if the bank is able to get them out of the house in less than a year. That being the case, I asked them if it was really worth ruining their credit score?

Sharon said it was, and at that point I sort of gave up and went back to my tea. Is Sharon making a mistake? Why? What else would you have said to try to convince her to decide otherwise?

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Comments

Dump it. Especially if she is in a Western Blight state! If you don’t live in one of those states- you have no idea….. I own a house that is fully paid for- but have a brother who had to walk away. If she does it before 2012 she will only be in a bad credit rating for three years and there will be no extra taxes due. The responsible thing to do is hold on. The reasonable thing is – let it go now before you owe the tax man!

She’s in debt and has the option of cancelling that debt and getting $20,000, at the cost of ruining her credit score. This option will always be available to her, regardless of how much in debt she is. So, she doesn’t lose anything if the house price goes down, but she may gain if the house price goes up. Conclusion: stick to the mortgage.

How much money she already spent does not matter. As for “throwing good money after bad”, if mortgage and rent payments are the same, again, stick to the mortgage: there’s always a chance of getting something out of it, if the house price goes up. With renting, there’s none.

I guess it depends on how much they have invested in the house and what other assets they might have to take care of bills in the future. Only saving $20,000 for a year means that they must only have a mortgage of about $250,000 at most. Sad to think that a $300,000 house dropped by $100,000 or 33% of its value. They must be in Nevada or Arizona or one of the hardest hit places.

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Who is Neal Frankle

I'm a Certified Financial Planner™ with more than 25 years of experience. I feel very blessed and hope to share my personal financial experience and professional wisdom with readers of WealthPilgrim. Read More »

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